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When I was young, an adult cousin told me to “splurge with money received as a gift,” calling it “found money.” That idea never felt right. As I learned later, it’s a classic case of mental accounting — the mistaken belief that money should be treated differently depending on where it came from.
Mental accounting is irrational, yet it’s everywhere. I teach Behavioral Finance and I’m always struck by how people think they’re rational but routinely make poor money choices. These biases matter in investing because they can lead people to buy high and sell low.
Richard Thaler, a pioneer in behavioral economics, identified this tendency in the 1980s. A famous example: would you drive 20 minutes out of your way to save $5 on a $15 calculator, or to save $5 on a $125 leather jacket? A survey found 68% would make the trip for the calculator, but only 29% for the jacket. The $5 is the same, yet people feel the calculator’s discount is a “better deal” because it’s a larger percentage.
Other common forms of mental accounting include the advice that retirees should reinvest capital gains but spend dividends. It makes no sense — $100 is $100 whether it’s labeled a dividend or a capital gain. The source doesn’t change its value.
Lottery winners often fall into the same trap. They treat windfalls as free money and overspend on boats, houses, and luxury items, burning through their winnings. If they’d “earned” the money, they likely would have been far more cautious.
Think about a car dealer offering a $400 protective coating on a $25,000 car. Do you say, “It’s only $400, why not,” or do you consider better uses for that $400? The coating’s value doesn’t change because it’s presented as a small add-on.
Money is just money, no matter its origin. Treat it with the same care whether it’s from earnings, gifts, investments, or luck. Don’t let mental accounting fool you.
Share examples of mental accounting you’ve seen — I’m sure you have them.
